Introduction to financial markets

Haves

Posess capital and lend it out (lenders) → households

Havenots

Have more needs than money and have to raise capital

• corporates (borrow money to start)

• government (debts)

• financial industry

Direct finance

borrowing money to buy something

Semi-direct finance

there is a third party invloved to bring the other parties together in order to get money borrowed and lent.

Transaction in a financial market

transaction between a have and a havenot

Indirect finance

money flows through the bank’s balance sheet and it transforms it into something new

Shallow banking

way to bring money from the haves to the havenots in a much less regulated way.

• mutual funds

• pension funds

Asset

possession that has value in an exchange transaction

Tangible/Real asset

derive value from their physical character and the utility they generate

Intangible asset

derive value from a legal claim to some future benefit

• patent

• copyright

• goodwill

• trademarks

Financial asset

intangible asset that represents a claim to future cash

Traditional asset class

• common stock

• bonds

• cash

Alternative asset class

• real estate

• commodities

• private equity

• hedge funds

• venture capital

• currencies

Commodities

basic, raw material or agricultural product that can be bought sold or traded, acting as input in production of other goods

Private equity

capital investment in private companies that are not publicly traded on stock exchange

hedge funds

private, pooled investment vehicle managed professionally for high net-worth individuals aiming for higher returns

Venture capital

form of private equity provided by investors to startups and early-stage companies with high growth potential, in exchange for minority equity stakes

Mortgage loans

providing money to purchase real estate

Consumer loans

credit extended by financial institutions to individuals, for personal, family or household expenditure

Tax debt

amount of money that is due and payable to a government tax authority but has not yet been paid by the filing deadline

Banking book

• mortgage loans

• consumer loans

• investment loans

• short term business loans

• government loans

Disclosure regulation

prevent issuers from defrauding (actual or potential) investors by concealing relevant information

Market conduct regulation

financial activity regulation in order to prevent insider trading, in order to impose trading rules, …

Financial institution regulation

prevent the default of financial intermediaries and to safeguard the payment system

Restriction on foreign participants

control money supply

Equity instruments

legally binding documents, such as shares or certificates, representing an ownership interest in a company or asset

Debt instruments

documented contract used to raise capital, wherein one party (borrower) receives funds from another (lender):

• loans

• debt securities

Maturity premium

additional return demanded by investors for holding long-term bonds compared to short-term bonds risk-free

Expected inflation premium

extra return demanded to hold nominal securities to hedge against the uncertainty of future inflation fluctuating above or below expectations

Credit spread

often embeds a liquidity premium. Differs for different maturities and borrower qualities

Modifiers

elements to adjust, qualify or amend the base price, rate, or performance metrics of an asset

High grade/Investment grade

bonds or issuers with a low risk of default, rated BBB- or higher

Speclulative grade

credit ratings below BBB-, indicating higher default risk

Split rating

when 2 or more credit rating agencies assign credit to the same debt security or issuer

Credit watch/Potential grading migration

formal designation indicating a company’s debt rating is under active review due to specific events like mergers or performance shifts

Downgrade/upgrade

negative or positive revision of an asset ‘s, company’s, or government’s credit rating or investment outlook

Fallen angel

bond or issuer downgraded form investment-grade to high-yield or junk status due to financial decline

Money market

market where instruments are being traded a maturity at issuance at most 1 year

Capital market

group instruments with a maturity at issuance of more than 1 year

Loans

contracts with two parties. Loans are transferable but the correct legal procedures have to be followed

Bonds

securities which are issued by 1 borrower and are being bought by many investors

National (Domestic) markets

transactions in local currency under supervision of local CB

Wholesale market

institutional investors

Retail market

retail investors

Call money

very short-term, interest-paying, unsecured loan, usually with a maturity of 1 to 14 days, used primarily by banks for inter-banks transactions to maintain required cash reserves

Unsecures Interbank Funding / Lending market

loans between banks maturing from 1 week to 1 year. International banking facility (onshore and offshore, in eurocurrency, transactions)

Secured lending using repurchase agreements (REPO)

sale of a security with a commitment by the seller to buy the security back from the purchaser at a specific price at a designated future date

Repo rate

the interest rate at which a central bank lends short-term money to commerce banks, often against government securities

General collateral

high-quality, liquid assets (government bonds, treasury bills, …) that are accepted in repo markets to secure cash borrowing

Haircut

a percentage reduction applied to the market value of an asset when used as collateral for a loan or repo transaction, accounting for risk and price volatility

Reverse Repo

short-term collateralized loan where one party buys securities (usually government debt) from a counterparty, promising to sell them back at a higher price later

Overnight repo

short-term loan where one party sells securities to another, promising to buy them back the next day at a slightly higher price

Term repo

short-term loan where one party sells securities to another and agrees to repurchase them at a specified future date

Open repo

short-term loan with no fixed maturity date, which automatically rolls over daily until terminated by either the borrower or the lender

Tri-partite repo

repurchase agreement where a third party (custodian bank or clearing organisation) manages collateral, valuation and settlement reducing operational risks

Commercial Paper (CP)

short-term unsecured promissory note used in the open market that represents the obligation of the investment company

Certificate of Deposit (CD)

financial product offered by banks, credit unions, and other financial institutions that provides an interest rate premium in exchange for the customer agreeing to leave a lump-sum deposit untouched for a predetermined period of time

Intercompany loans

financial transactions where one legal entity within one corporate group, lends funds to another entity within the same group

Trade credit

an arrangement to buy goods and/or services on account without making immediate cash or cheque payments

Straight loans

short-term, interest-only business financing tool where the borrower makes periodic interest payments and repays the full principal at the end of the term

Overdrafts

financial service where a bank allows a customer to spend more money than is currently available in their account, up to an agreed limit

Factoring

financial transaction where a business sells outstanding invoices to a third-party company, known as a “factor”, to get immediate cash

Forfaiting

method of international trade finance where an exporter sells their medium-to-long-term receivables to a financial institution (forfaiter) at a discount receiving immediate cash

On-the-run issues

securities that are the most recently issued. Highly liquid bonds, which trade at a premium (lower yield)

Off-the-run issues

US Treasury securities that are no longer the most recently auctioned debt for a specific maturity

Discount securities

financial instruments issued at a price below their face value and redeemed at full face value upon maturity, with the difference acting as the investor’s interest’s income

Debt markets

markets where debt securities trade

Zero-coupon

debt instrument that pays no regular interest, but is issued at a deep discount to its face value, providing a return through appreciation

Fixed coupon

a set, unchanging interest rate paid on a bond or fixed-income security, calculated based on the par value of the security throughout its life

Floating coupon

a bond interest payment that adjusts periodically based on a benchmark interest rate, plus a fixed spread

Multicoupon

secure system representing a collection of coupons that a user can redeem with vendors for goods or services

Linkers

fixed-income securities designed to protect investors against inflation

Announcement date

date on which the bond is announced and offered to the public

Maturity date

date on which the amount is due

Issue date

day on which the security is issued

Dated date

day from which the first coupon starts to accrue interest

Settlement date

day on which the parties will exchange cash and securities

Sovereign bonds

issued by the highest level of government in a country

Subnational government debt

issued by states, regions, provinces, countries, …

Supranationals

multilateral financial institutions

Corporates

issue corporate bonds

• public utilities

• transportation economics

• bank and finance companies

• industrials

Debendure bonds

not secured by a specific pledge of property

Guaranteed bonds

cash flows are guaranteed by a third-party

Convertible bond

hybrid corporate debt security that pays interest but gives the holder the option to convert the principal ino a predetermined number of common stock shares

Exchangeable bond

hybrid debt security allowing holders to convert the bond into shares of a company other than the issuer

High yield bond

debt securities with lower credit ratings

Objectives primary market

• ensure effectiveness

• encourage participation from a large range of investors

• minimize competition

• minimize placement risk

• foster transparency

Objective secondary market

• low transaction costs

• continuous and wide disseminated price information

• safe and rapid settlement

• efficient custodial and safekeeping services

Shares

equities in companies

Stocks

shares or bonds

Equity

now they represent a nominative or a dematerialized ownership interest in a corporation

Cash dividend

direct payment of money made by a company to its shareholders

Stock dividend

payment made by a corporation to its shareholders in the form of additional shares rather than cash

Choice dividend (scrip dividend)

gives the shareholder the coice between a cash payment or in additional shares of company stock

Interim dividend

paid out of realised profit + final dividend

Bonus dividend

paid out of the reserves

Withholding tax (WHT)

advance payment of income tax deducted at the source by payers on wages, dividends, or interest (30%)

Book building

capital raising mechanism used by companies in IPO or FPO to determine the share price through market demand

Bought deal

securities offering where an investment bank or underwriter commits to purchasing an entire issue of stock from a company at a fixed price before filling a prospectus

Sponsor

exchange sponsored indices, independently sponsored indices